Reforming Stock Trading Inside the Beltway
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Insider trading carries with it the possibility of civil and criminal penalties for members of the general public. Yet, members of Congress have enjoyed freedom from punishment for engaging in the misappropriation of information they receive in the service of their jobs. The complex history of securities law is built upon case law which has failed to reach congresspersons due to the lack of a binding fiduciary obligation between them and the general public. The existing structure of representation—where legislators are expected to act in the best interest of their constituents—is irrelevant in the application of insider trading law to members of Congress. In order for there to be a binding obligation to refrain from engaging in insider trading, there must first exist a fiduciary duty between a trader and a communicator of material, nonpublic information. In the case of members of Congress, that relationship does not exist since their duties to the American people are based on representation as opposed to a fiduciary obligation.
This glaring loophole left open by case law has allowed some members of Congress to outperform the market, the general public and even some hedge fund managers for decades. This, along with the fact that there were members of Congress trading stock before major disclosures during the financial crisis and recovery of 2008 and 2009, led to the enactment of STOCK Act of 2012. This Act was introduced as a statutory fix to the limited reach of case law on congressional insider trading and was adopted with near unanimous support in both chambers. The STOCK Act gave explicit direction to reviewing judges that the members of Congress were not to be exempt from insider trading laws and premised this newfound liability on a codified duty the members owe to the public when in receipt of material, nonpublic information. Additionally, the new law called for members to disclose all of their stock transactions while in office. Despite the Act’s promising changes, the new regulations practically changed nothing for those inside the Beltway.
Members of Congress have enjoyed enormous amounts of wealth from their active stock portfolios. In 2021 alone, members disclosed nearly 4,000 securities transactions worth more than $550 million and over 50 members failed to properly report their trades. The penalties dictated by the STOCK Act consists entirely of a standard $200 dollar penalty, but it is often waived by the ethics committees after members cite excuses of simple human error from third party actors like their accountants or even ignorance of the law. The problem with the STOCK Act is that it was not given an enforcement mechanism with teeth and has otherwise been largely unenforced due to the difficulties associated with proving the required elements of insider trading and because of the constitutional protections members enjoy. For a successful action to be brought against a trader, it must be clear that the information received by said trader was material and not public. However, defining what material and nonpublic information actually means has proven difficult, particularly when it relates to government briefings. To date, there has not been a successful federal enforcement against the misuse of information pertaining to the entire economy as there is no clear definition of what constitutes material information for market performance as a whole. Further, nonpublic information can be hard to define since congressional briefings often include information accessible to all via the internet, and information not yet widely known by anyone outside of the government while also benefiting from nonpublic government analysis and expertise.
An additional hurdle for the STOCK Act pertains to the protections afforded to members of Congress to be free from questioning for any legislative activity they engage in as provided by the Speech and Debate Clause in Article 1, section 6 of the Constitution. This makes it difficult for government lawyers to investigate congresspersons who are engaging in legitimate legislative business during congressional briefings but who could also be acquiring potentially material nonpublic information. Further, the question of who should enforce the STOCK Act remains unanswered. While the 112th Congress did not answer this question, some have suggested either the DOJ or the SEC, both having expertise in securities litigation. However, the lack of independence of the DOJ—with it being under the purview of the ever-changing executive branch—makes it an ill fit to serve as the enforcer of the STOCK Act. The SEC could be the better option, but that agency would still require the independent commissioners, appointed by both Democrats and Republicans, to investigate their budget appropriators and overseers. This conflict of interest leaves no opportunity for the STOCK Act to be effective law combating the rampant self-enrichment taking place on Capitol Hill.
In early 2020, the shortcomings of the STOCK Act opened the door for some legislators to protect their portfolios before the markets sold off due to the global panic surrounding the COVID-19 pandemic. This sort of conduct is beneath the character of those who should be running our country. Legislators are elected to be representatives for their people and are thus expected to act in the community and nation’s best interest. Instead, the country witnessed 5 senators look out for their own stock portfolios as they cashed out weeks before the market sell offs started to occur. One of them, former Senator Kelly Loeffler did not just sell her stocks to prevent impending losses but also invested her newly liquidated funds into stocks that would perform well in a pandemic economy. The former Senator and her husband, the chairman of the New York Stock Exchange, invested six figures into a tech company focused on teleworking solutions for remote work from home.
Another instance of the misappropriation of information from seated members of Congress came from Senator Richard Burr. The Senator from North Carolina did not look to cash in the same way as former Senator Loeffler but instead warned his brother-in-law of the impending market downturn and told donors at an expensive luncheon of the dangers that would likely follow the once-in-a-century pandemic as he described it. One group Senator Burr never publicly warned was his constituents. Not only could he have saved the retirement funds of his hard-working and blue-collar constituents of North Carolina, but he could have also saved lives had he taken his job as chairman of the Intelligence Committee seriously. Instead, Senator Burr looked out solely for himself and his wealthy friends. The acts of these senators and various other members of Congress over the past several decades have been immoral, selfish, and should not be typical of our representatives who are elected to serve the public, not themselves.
To correct this systemic issue, Senators Jon Ossoff and Mark Kelly recently introduced a bill that would prevent any stock trading by members of Congress. This bill requires all members, their spouses, and their dependent children to put their stock portfolios into a blind trust for the tenure of the member’s elected service. The Democratic Senator’s proposal would ensure that members do not use any of the inside information they acquired from their position for their own personal gain. Further, this bill contains the penalty of requiring a violator to pay a fine equal to their congressional salary for the year.
Senator Ossoff’s proposal goes further than other similar proposals currently on the Senate floor, including a version from Senator Josh Hawley. Senator Hawley’s proposal does not extend the prohibition and the blind trust requirement to the dependent children of members and does not levy the same penalties against those who misappropriate the inside information. The expanded reach to dependent children provides another layer of protection against circumvention that members could otherwise engage in by putting accounts in their children’s name. And the much-improved monetary punishment from Senator Ossoff’s proposal over the STOCK Act ensures a significant deterrent is in place instead of nominal fines. Senator Hawley opts for a milder punishment of requiring disgorgement of profits made by congresspersons and their spouses who engage in insider trading. The two proposals also differ in their chosen enforcement mechanism with the Government Accountability Office being the reviewing entity in Hawley’s bill, while Ossoff’s plan gives the power to the Congressional ethics committees.
One deficiency present in both bills is the lack of an automatically administered suspension or perhaps expulsion from Congress. Without such a sanction, these proposals fall short in adequately discouraging the legislators who find it appropriate to focus on their pocketbooks over their principal duties as a representative of the public. When legislators commit a dereliction of their duty by failing to put the people of their state first, the laws should not see their penalties end with pecuniary losses but instead should also include a required vacating of their seat. Our country needs to incentivize those persons who want to serve the interests of the public and not their own. Any member who violates any new insider trading prohibition on Congress should have no second chance. Proposals to curb Beltway insider trading should include a suspension from that session of Congress or even a permanent ban from Capitol Hill. This would be the most apt punishment for those, like Senator Burr, who prioritize profits over their constituents during times of crisis which—in certain instances—can be the difference between life and death for some.
Fortunately, reform for this glaring insider trading loophole is gaining a lot of traction. The public is overwhelmingly in favor of prohibiting congressional insider trading. Although there was significant pushback from top party leaders, including House Speaker Nancy Pelosi, who long refused any efforts at reform, this push for change has gained so much support that even the Speaker herself has changed her position on the matter. She now has publicly welcomed reform but at the same time sees no need for it herself, stating that she believes in the integrity of her members. Regardless of the Speaker’s personal beliefs, members of Congress have done alarmingly well with their investments over the last several decades. Legislators should not be looking at public office as a money-making opportunity and should not be allowed to “play the markets” in lieu of serving their constituents.
The current proposals on the Senate floor show promise for fixing this long-standing flaw of the current insider trading policy, and if the reform efforts are successful, Capitol Hill will be a better place because of it. Senators Ossoff and Kelly’s plan do the most to prevent continued abuse by expanding the reach to dependent children and ensuring that there can be no circumvention of this law by close family members. Requiring a penalty greater than what is currently prescribed by the STOCK Act serves as a greater deterrent to insider trading by members of Congress than Senator Hawley’s plan. While these proposals would be best served by including more severe penalties such as suspension of office for violators, these bills are nonetheless a promising first step towards ensuring that our legislators go back to working for the people.
About the Author: Cody Colton is a 2L at Cornell Law School. He graduated from the University of California Irvine, where he majored in political science with an emphasis on legal studies. Cody is interested in securities litigation and white-collar crime. He is an associate for Cornell Law School’s Journal of Public Policy and its online publication, The Issue Spotter.
Suggested Citation: Cody Colton, Reforming Stock Trading Inside the Beltway, Cornell JKL. & Pub. Ploy, The Issue Spotter, (March 15, 2022), https://live-journal-of-law-and-public-policy.pantheonsite.io/reforming-stock-trading-inside-the-beltway/.